Archive for December 7th, 2009

The November 30, 2009 Wall Street Journal ran an article by Henry Mintzberg, professor at the Desautels Faculty of Management at McGill University in Montreal titled No More Executive Bonuses! The problem isn’t that they are poorly designed. The problem is that they exist.

Mintzberg says: “These days, it seems, there is no shortage of recommendations for fixing the way bonuses are paid to executives at big public companies. Well, I have my own recommendation: Scrap the whole thing. Don’t pay any bonuses. Nothing.”

We say “WHAT?”

First let us say that we believe that Professor Mintzberg is among the top five organizational theorists in the world. In own biography on his website Mintzberg says: “I devote myself largely to writing and research, over the years especially about managerial work, strategy formation, and forms of organizing”.

Mintzberg’s many books and articles are profound treatises on management, strategy and organizational design. We eagerly await and read every publication in the past finding well thought out and well supported critique of issues associated with organization theory. This article, however, is more a “knee jerk” reaction to the state of affairs in the arena of executive compensation. Unfortunately it comes off as a common and uninformed position and worse, it does little to advance the task of properly structuring executive pay.

Perhaps Professor Mintzberg’s intention was to present a controversial position that would help to foster dialogue about the state of executive pay. But whether or not that was his intention, we hope that Professor Mintzberg’s avid readers (ourselves among this group) don’t take his suggestion to “scrap the whole thing” as gospel.

We will continue to advise our clients to design reward programs that are unique to their organizations that drive business success. Most of these programs will include bonuses.

Zach Carter’s article Shareholders Alone Can’t Correct ‘Too Big to Fail’ in the November 23, 2009 issue of The Nation got our Editorial Board talking about “say on pay” and shareholders rights. Mr. Carter says: “It’s easy to see why empowering shareholders to deal with bloated CEO pay might be attractive. We’ve just watched several regulators, from the SEC to the Office of Thrift Suspension to the Federal Reserve, fall down on the job–maybe shareholders who want to see a good return on their investment will exercise more prudence.”
Although Mr. Carter didn’t specifically address “say on pay” in his article, it is thought to be one approach that could possibly empower shareholders to “control” pay.

Let’s take a closer look at say on pay and how it might play out, for better or worse.

“Say on pay” proposals are all structured as “non-binding,” making these just advisory votes by shareholders, which would not necessarily dictate any action by the Board. The “nonbinding” aspect of these votes might be “good news” for a couple of reasons.

First, the “say on pay” vote won’t be detailed enough to provide boards with any really actionable steps to take. A simple “no” vote on pay only suggests that pay is too high, not how high it is. And for that matter a “yes” vote simply says the pay is not “too high” rather than endorsing any of the specifics of the compensation structure. Compensation for executives is and should be complex., but not so complicated as to be unexplainable or unsupportable. Rather, the compensation structures should include a wide variety of pay components: base pay; short-, medium-, long- and career-term incentives tied to specific business goals; executive benefits; and perquisites. The combination of these components and the messages they send are key to designing programs that link compensation to the business strategies.

Second, because of the complexity of these compensation structures, it is possible that shareholders won’t understand the underlying linkages and will react to compensation based on a number alone that appears on the surface to be either ‘reasonable’ or ‘unreasonable’. If the shareholders don’t fully understand the reasoning behind the compensation structure they can’t make an informed decision on the outcome. Voting down a well thought out compensation structure that on its surface “appears” to be too large would not benefit the company or the shareholders, while voting up a compensation structure that on its surface appears reasonable, but which is not well structured to drive business results, wouldn’t benefit the company or its shareholders either.

And let’s not forget the obvious – if neither the executive nor the employer understands the compensation structure, then don’t expect the board or shareholders to understand either. In that instance, you’ve got an even bigger problem.

A positive outcome of “say on pay” will be, we hope, renewed interest and effort by Boards and management to open a rich dialogue with shareholders about business practices and how compensation can help to drive the business strategy. For far too long now, there has been little discourse between Boards and shareholders about how the business plan is linked to the rewards strategy. In the absence of this dialogue, institutional shareholders can and will (as they have done in the past) look to ISS Governance Services (a business unit of Risk Metrics, Inc) for advice on how to vote.

For all ISS Governance Services’ claim to provide “… complete analysis with deep insight on each ballot issue”, ISS Governance Services is essentially a “black box” that is an inflexible model where data on more than 10,000 US companies must be “normalized” in order to provide consistent recommendations. The nuances (which Grahall believes must be considered in order to create appropriate compensation structures) are averaged out or simply ignored. As you might, imagine we don’t see this as a positive outcome.

It is possible that “say on pay” votes, even though non-binding, could become the equivalent of a “bleeding edge” endorsement or indictment of Board governance and fiduciary duty, effectively becoming binding in their application and ability to control executive pay. Boards with “yes” votes get a “rubber stamp” on their decision and Boards with “no” votes could possibly risk civil suits if they take no action. In the end, making “say on pay” a defacto binding vote, transferring these decisions from an informed group (i.e., the Board) who (we would hope) has made decisions based on solid data, business strategy and sound philosophy to an uniformed group (i.e. shareholders) who made decisions based on imperfect data or based on a “gut reaction”

So how will Boards react? Trapped between the challenge of educating shareholders and the growing authority of ISS Governance Services, the easiest thing for Boards to do is to become less thoughtful in their compensation decisions and simply set executive pay in the high end of whatever ISS determines to be the “approved envelope” even if this is not the “right” level of pay for the executive.

We hope that Boards do not shy away from their responsibilities and continue to invest time and effort to connect executive compensation to business strategies and then take the additional steps to thoroughly communicate their decisions and how those decisions were made to shareholders prior to the proxy vote. Without this any effort to “fix” the corporate governance process and executive pay by empowering shareholders will fail.

Everybody loves a great quote and so we couldn’t resist when, according to an article and video clip offered through the New York Times November 19, 2009 Dealbook (the article aptly titled Morgan Stanley’s Mack: ‘We Cannot Control Ourselves’), Morgan Stanley’s John Mack said “‘Regulators have to be much more involved… We cannot control ourselves.’” The article continues: “Wall Street is facing more scrutiny from Washington after the financial crisis last fall. For John J. Mack of Morgan Stanley, that’s just fine.”The article goes on to quote Mr. Mack in his praise of the dozen or so regulators who now patrol Morgan Stanley’s offices in the wake of the firm becoming a bank holding company. “I love it,” he said, adding that it forced him and his firm to watch the level of risk they were taking on.

Hmmmm, he loves it? We kind of hope NOT since the definition of love according to the Merriam Webster on line dictionary includes “strong affection for another arising out of kinship or personal ties, an attraction based on sexual desire, or an affection based on admiration, benevolence, or common interests.” Then again, maybe he means “love” as in “a score of zero (as in tennis)”. In any event it is clear that “love” in this content is an overused term.

Listening to the video tape (available on Huffington Post Mack says: “We have 15 to 20 Fed regulators in our building 24 hours a day…”
Hyperbole, perhaps? We would be delighted to see regulators work even 8 hours a day.

On a more serious note, we expect that Mr. Mack, who has taken a beating in the markets and, in terms of talent pilfering from Goldman and JP Morgan, might be advocating for regulation to level the playing field and create a dampening effect or at least a distraction to these powerhouse competitors.

But has Mr. Mack really thought this out? Time and again we are reminded that the White House is surrounded by Goldman alumni and advocates. Whether it be the Chief of Staff to Treasury Secretary Geithner (or Geithner himself for that matter), or the Deputy Director of the National Economic Council, or the many former Goldman protégés of Robert Rubin embedded in various positions of power, Goldman’s influence runs deep.

It seems there couldn’t be a better time for regulations to be written or regulators to be unleashed that would benefit Goldman Sachs. In fact, it might be in Goldman’s best interest to have these regulations written now, before someone realizes our government might be of and by the people but for Goldman Sachs. Perhaps Mack didn’t think of that when he expressed his delight at having regulators patrolling his hallways. Or maybe this is his way of sending a message that he wants one of those high paying GS jobs?

Regardless of the above speculation, the truth remains that our President has a great challenge ahead of him. America just a few years ago had great “brand” image. Our greatest export might have been the fact that we have rules, regulations – and a level playing field that gave investors a sense of security and confidence. Today that image is badly tarnished and we are at risk of losing one of our best products: investor confidence. We need to fix that.

Published in World at Work December 7, 2009
Despite signs of economic recovery, many employers plan to maintain a conservative stance well into 2010, with 31% of those polled in a recent Towers Perrin survey indicating they plan to reduce head count on a targeted basis in the coming year and another 6% planning for a significant reduction in staff.
The results of the new survey are improved over 2009 reports (42% and 35%, respectively), yet they reflect a continued level of concern among America’s businesses on the speed of recovery from the recent recession. In contrast to this projected employment contraction, 21% of the companies surveyed actually plan to increase hiring in the coming year, compared with just 3% that did so in 2009. In addition, 16% of companies that froze or reduced hiring in 2009 are planning to increase hiring next year. At the same time, companies are also expressing increased concern about keeping their critical talent as the recovery picks up steam and jobs become more available to top performers.